Loan Note: Oaktree’s five credit market observations; Varde looks to a stressed future

Concerns but also opportunities feature in Oaktree's assessment of the credit cycle; Varde sees the potential for stressed deals; and Comvest bolsters its special sits ranks. Here's today's brief for our valued subscribers only. 

They said it

“The price, seasonally and calendar-adjusted private consumer spending, which had supported the German economy in the course of the year to date, was lower than in the previous quarter”

German statistics body Destatis reports GDP fell by 0.2 percent in the fourth quarter of last year, putting the country on the brink of recession.

First look

Peering into the future: Oaktree assesses the credit market cycle (Source: Getty)

Opportunity and risk, according to Oaktree
Oaktree has applied the microscope to the credit markets in its latest Performing Credit Quarterly report for the fourth quarter of last year. Here’s a summary of five of the firm’s observations:

1. Defaults and volatility up: In 2022, interest rate risk was the major driver of relative performance in fixed income, with floating rate outperforming fixed rate. But this is a situation likely to change if we see a slowing of major economies. With only a small percentage of loans maturing before year end, near-term default risk is low but rising. Oaktree predicts “significant volatility and dispersion based on quality”.

2. A void at the larger end: With banks seeking to reduce balance sheet risk, they have little appetite to underwrite large-scale financings for leveraged buyouts and M&A. Private debt funds with sufficient capital and flexibility are filling the void, attracted by larger average yield spreads than are typically found in traditional mid-market deals. Lenders are also now able to obtain significant investor protections.

3. Fixed-rate bonds offer relative value: With the possibility of investor focus shifting from interest rate risk to credit risk, investment-grade and high-yield bonds may become more attractive than loans as economies weaken. Bonds rated BB and higher offer “minimal credit risk, attractive yields and limited near-term maturities”. For lower-quality issuers, the outlook is much less optimistic.

4. “Junk loans” a concern: Given rising borrowing costs, high leverage ratios and eroding fundamentals, the outlook is challenging for leveraged loans going forward. The increase in downgrades in recent months is possibly the prelude to an increase in defaults, and these defaults could face lower than expected recoveries due to the prevalence of covenant-lite loans.

5. Opportunities for bargains: The report quotes Oaktree co-founder and co-chairman Howard Marks, who recently expressed the view that lenders and bargain hunters face much better prospects now than they did during the low-rate period from 2009 to 2021. He advises to be prepared for a change in strategic focus: “The investment strategies that worked best [over the past 13 and most of the last 40 years] may not be the ones that outperform in the years ahead.”

Varde views on what lies ahead
The latest Varde Views from fund manager Varde Partners presents three possible credit cycle scenarios, ranging from the mildly concerning to the deeply troubling.

The first of these sees a smooth deleveraging, modest growth forecasts and a rapid moderation in inflation. Although this sounds rosy enough, there will be a multi-year deleveraging cycle with “bumps in the road”, particularly where leverage is high and in segments of the credit market that are materially impacted.

The second would be a stagflation scenario with policy makers unable to stop inflation and growth continuing to slow. Here, corporates would be pushed into faster and more disorderly deleveraging and the strong economic environment of 2022 would be a thing of the past.

In the third scenario, a worse than expected recession would lead to more severe deflation than currently expected. This scenario is made more feasible by the Fed apparently favouring this outcome over sticky inflation. Mitigating against this outcome is the strength of labour markets around the world. Varde points out that deflationary deleveraging “tends to be relatively good for credit” due to eventual intervention by central banks.

Across all three outcomes, Varde says there is potential for distress and dispersion. Signals suggest that the severity of deleveraging is likely to be somewhere between the global financial crisis and that experienced in the 2015-16 cycle.


Comvest hires special sits veteran to build platform
Comvest Partners, a Florida-based private credit and equity investment firm, has brought in Charles Asfour as a partner. Asfour will serve on the investment committee of the Comvest Special Opportunities investment platform, which focuses on providing hybrid structured debt or non-control equity capital solutions to sponsored and non-sponsored mid-market companies.

Working out of Comvest’s Chicago office, Asfour will be responsible for structuring and managing special opportunities investments.

Asfour has years of experience originating, executing, and managing special situation-oriented structured capital investments. He worked for nearly 10 years at Victory Park Capital Advisors, and by the end of his time there he led that firm’s special opportunities platform and team. In 2019 he left Victory Park to create Aves Capital Management, which was likewise devoted to special situation investments.

Comvest Partners has also in recent days added John Mendell to its investor relations team. Mendell has more than 25 years’ experience in investment and capital raising. He worked on the US direct lending team at Tennenbaum Capital Partners and its successor organisation, BlackRock. Before Tennenbaum he held senior fundraising roles at both Ares Management and TCW MedWest.

Akin Gump hires private credit partner
Law firm Akin Gump has announced the hire of Fergus Wheeler to the firm’s special situations and private credit team as a partner in the London office. Wheeler joins from White & Case, where he was a debt finance partner with a particular focus on private credit.

Wheeler has over 15 years’ experience working in leveraged finance and has been at the forefront of legal developments in the private credit asset class for almost a decade. He advises international private credit funds and a range of alternative capital providers investing across the capital structure, primarily in performing credit, but also in stressed and distressed situations.

Wheeler will help establish and lead Akin Gump’s performing private credit platform in London, as well as support the firm’s global special situations and private credit team, which is led by Ranesh Ramanathan and Dan Fisher. He will also work closely with the firm’s global financial restructuring practice in connection with the financing of stressed and distressed credits and liquidity solutions, liability management exercises and restructuring and workouts.

New lending arm for Dekel
Los Angeles-based real estate merchant bank Dekel Capital has launched Dekel Correspondent Lending which on behalf of capital providers, including a global asset manager and large European bank, will originate balance sheet and CMBS loans for the acquisition, refinancing and recapitalisation of commercial real estate assets including build-to-rent and single-family rentals.

Real estate finance veteran Vishal Vanjani has joined the firm as managing director to lead the new initiative along with Ben Markiles who joins the firm as associate.

DCL adds to the bank’s range of services that provide real estate investors and owners with financial solutions across the capital stack including permanent loans, B-notes, mezzanine financing, preferred equity and joint venture equity.

LP watch

Institution: Pennsylvania Public School Employees’ Retirement System
Headquarters: Harrisburg, US
AUM: $70.31 billion
Allocation to alternatives: 30%

Pennsylvania Public School Employees’ Retirement System, advised by Aksia, has committed $250 million to the Sixth Street Lending Partners fund, according to the pension’s December meeting materials.

PSERS and Sixth Street have a long-standing partnership, with the LP having committed approximately $1.7 billion to Sixth Street-managed funds. The GP also represents PSERS’ largest exposure to the private credit market, with about $1.5 billion (NAV including unfunded commitments), as of 30 June 2022.

The BDC, which is targeting $4 billion in capital commitments, primarily invests in senior debt in upper mid-market US companies. It is the firm’s second BDC – Sixth Street Specialty Lending launched in 2010. Sixth Street has invested approximately $18.9 billion through direct lending investments since 2011, generating a 14.3 percent unlevered gross IRR.

Today’s letter was prepared by Andy Thomson with John Bakie, Christopher Faille and Robin Blumenthal